Case Study: UK expat with UK assets and non UK spouse – what happens with IHT?

For expats who still regard Britain as their ultimate home, their worldwide assets remain within the scope of UK inheritance tax even if they are not UK tax resident. UK inheritance tax liability is based on domicile which is different to tax residence. Domicile is a much broader concept of where someone regards as their home. At birth an individual acquires their father’s domicile as their domicile of origin, unless their parents are unmarried in which case they would take their mother’s domicile as their domicile of origin. For those with a domicile of origin in the UK, HMRC argues that it is very difficult to lose your domicile of origin and acquire a domicile of choice elsewhere, and this position is supported by case law.


Increased limit on spouse exemption

From 6th April 2013, the limit on spouse exemption has increased to £325,000 on assets passing from a UK domiciliary to their non-UK domiciled spouse. This is in addition to their available inheritance tax nil rate threshold, which remains £325,000. A total of £650,000 of assets can now pass tax free to the surviving non-UK domiciled spouse.


Electing to be UK domiciled

While the increased spouse exemption limit is helpful, it may not be enough to eliminate the inheritance tax liability for all couples who find themselves in this situation.
In a further change to the rules, where a non-UK domiciliary receives or inherits assets from their UK domiciled spouse, they can now elect to be UK domiciled for inheritance tax purposes. The most likely scenario in which this election would be exercised is when their UK domiciled spouse died and the value of the assets they inherit exceeds the combined nil rate threshold and the limited spouse exemption so that there would otherwise be a UK inheritance tax bill. In these situations, the surviving spouse has two years following the death of their spouse to elect to be UK domiciled. The election applies for inheritance tax purposes only, and does not affect their tax residence, or require them to reside in the UK or to be able to reside in the UK.

The election enables unlimited spouse exemption to apply and would thereby eliminate the UK inheritance tax liability on the first death where everything is passing to the surviving spouse. However, the surviving spouse’s worldwide assets would then be subject to inheritance tax on their death. Previously, as a non-UK domiciliary, it would only be their UK situated assets which would have been liable to UK inheritance tax. Consequently, making the election could result in a larger overall inheritance tax bill in the future on the couple’s combined assets. Electing to be UK domiciled will depend on the value of the couple’s assets, where they are situated and how they are held. The election to be UK domiciled is permanent but would lapse if the surviving spouse is non-UK resident for four complete tax years in the future following the election.  

 NOTE: Should the non UK spouse die within 4 years (after they have declared UK Domicile) their worldwide assets are now subject to UK IHT with only a £325,000 threshold. IE total assets (£2,000,000 – £325,000)* 40% = £670,000 IHT Bill.  In this case one should take out an Asset Protection Plan for the 4  years from declaring UK domicile to mitigate this expense.